The tracking error for equity ETFs/index funds cannot exceed 2 per cent and for debt funds the tracking gap – on an average over a year – should be within 1.25%, as per the recent SEBI circular on passive funds Is.
The circular is titled – ‘Evolution of Passive Funds’ and considered the recommendations of the Mutual Fund Advisory Committee (MFAC) based on the growing interest for passive investment products characterized by transparency, diversification and lower cost as compared to active funds.
The annual standard deviation of the difference in daily returns between the underlying equity index and the ETF/index fund’s NAV based on rolling data for the past one year is the tracking error and should be within the 2% levels. This metric measures how well the fund performs in comparison to the returns of the target index.
As per the circular, all ETFs/index funds (including debt ETFs/index funds) should disclose tracking errors on a daily basis based on the rolling data for the past one year on the websites of the respective AMCs and AMFIs. SEBI circular
Note that for funds in existence for a period of less than one year, the annual standard deviation will be calculated based on the available data.
Apart from tracking error, idle funds should also disclose ‘tracking gap’ on a monthly basis. The difference between the return of the index product from its benchmark index on a particular date is called the tracking difference.
The tracking difference has to be disclosed for 1 year, 3 years, 5 years, 10 years and tenure from the date of allotment of units.
The tracking gap is limited to 1.25% for debt ETFs/index funds. “The average annual tracking difference over a period of one year should not exceed 1.25% for Debt ETFs/Index Funds,” the SEBI circular said.
The circular states that any deviation from these limits should be brought to the notice of the trustees along with the corrective action taken by the AMC.